Oct. 20 (Bloomberg) -- Japanese regulators should create rules to spur mergers of real estate investment trusts to help them survive, said Yuichi Hiromoto, chief executive officer of Mitsubishi Corp. UBS Realty Inc.

Japanese REITs, corporations that pool investor funds to buy and manage property, are under pressure after the global credit crunch led to a series of failures in the property industry. The Tokyo Stock Exchange REIT index reached an all-time low of 711.30 on Oct. 10, compared with 1,000 at its April 2003 inception. The index rose 5.9 percent to 828.24 in Tokyo today.

New City Residence Investment Corp., the first Japanese REIT to fail, declared bankruptcy on Oct. 9 because it couldn't refinance existing loans or raise funds to pay for properties it had committed to buy.

``Regulators have sensed the urgency after the fall of New City,'' said Hiromoto in an Oct. 17 interview. ``No one had expected the market to turn out to be this way, so no regulation related to market consolidation was in place. The government has to review its rules quickly.''

No Framework

If REITs could consolidate, they might create the sort of scale needed to borrow money, allowing them to finance acquisitions. Currently there is no framework that lays out ground rules for REIT mergers. Regulators have expressed concern about the treatment of minority shareholders in potential transactions.

``There is no basis for the current credit crunch'' affecting Japan's property market, Hiromasa Takakura, managing director of investment banking at Nikko Citigroup Ltd., said in an Oct. 17 e-mail.

``Banks are claiming that high loans-to-value raise more uncertainties, but they shouldn't have any concerns about not getting the principal or interest back, as all the J-REITs are profitable,'' Takakura said. Nikko Citigroup underwrote about 25 percent of the initial public REIT offerings in Japan.

Advocates say consolidation is the only way to preserve value. The REIT Index has declined 73 percent since its peak in May last year, a drop that wiped out 4.5 trillion yen from the index, according to Bloomberg data.

Regulators should also review rules that restrict a trust's ability to raise funds via methods other than by traditional equity or debt, said Takakura.

New lending to the real estate sector fell 19 percent in the three months ended June, according to the Bank of Japan.

``J-REITs should be allowed to issue other types of securities such as convertible bonds or preferred shares, etc,'' said Takakura. ``That would help the market.''

Bankruptcies

Business failures rose at the fastest pace in eight years in September, led by construction and real estate companies that struggled to obtain funding in the wake of the global financial- market turmoil.

Bank of Japan Governor Masaaki Shirakawa said today that the bankruptcies in the industry are making it more expensive for some companies to borrow money.

The central bank ``needs to carefully watch the increase in credit costs on the back of a rise in bankruptcies in the construction and real estate sector,'' Shirakawa said at a quarterly meeting of its branch managers in Tokyo.

`Structural Problems'

In the past year, Japanese REITs fell more than those in other markets even though the subprime crisis damaged overseas real estate markets more severely. The 49 percent decline in Japan compares with the 34 percent drop in the U.S. and 33 percent slide in the U.K., according to AME Global REIT indexes.

REITs listed on the Tokyo Stock Exchange face delisting when no dividends are paid for a year. Other listed companies are only delisted when they have liabilities exceeding assets for two consecutive years.

The current regulations for REITS are too strict, said Hiromoto, who set up Japan Retail Fund Investment Corp., a commercial property trust, and Industrial & Infrastructure Fund Investment Corp.

Credit Suisse Group AG said the New City failure highlighted a management structure problem with REITs.

Banks often only look at the creditworthiness of REITs' external management when providing loans, rather than the properties held by the trust, Credit Suisse analysts Masahiro Mochizuki and Yoji Otani said in a report published on Oct. 9.

New City's total assets were valued at 202.7 billion yen at of the end of February. By the time New City filed for bankruptcy, its market capital was 1.3 billion yen, down from an average of 93.3 billion yen during 2007.

Japan's first two REITs, Nippon Building Fund Inc. and Japan Real Estate Investment Corp., listed on the Tokyo Stock Exchange in 2001. The market capital of the 41 REITs listed on the Tokyo Stock Exchange gained to a peak last May of 6.8 trillion yen before falling to the current 2.3 trillion yen.

To contact the reporter on this story: Kathleen Chu in Tokyo at kchu2@bloomberg.net.

Last Updated: October 20, 2008 03:27 EDT